Saturday, April 11, 2009

What is a stock exchange?

A stock exchange is a company that make it possible for people who want to sell stocks and other investment instruments to be connected to a buyer. We can thus say that it facilitate the selling and buying process of stocks.

It is not possible for a buyer to meet a seller directly. Each investor must have a broker and when you want to sell or buy a stock the broker will place your order in the exchange computer. When you get a seller or a buyer the exchange will tell your broker and finally you will be informed by him. You cannot deal directly with the exchange yourself. Nor can you meet the person that is buying your stock.

Apart from facilitating the buy-sell process the stock exchange offer several advantages.

1. You do not have to go around looking for people to buy shares. Also even though some companies sell stocks over the counter this is a daunting task and this can be done using a stock exchange in minutes.

2. The stock exchange protect the investors in that you are certain to get a share when you buy and to get your money when you sell. You also have consumer protection institutions that can initiate actions if your rights have been infringed.

3. Companies that are listed on the exchange have to abide to some rules. They need to have a certain market capitalisation, they need to follow accounting standards, they need to issue financial reports every quarter among others, their shares have to be above a certain value, etc. As you can see, if you are investing in a company listed on an exchange you are sure that the company is secure.

4. Companies must get shareholders agreement before going ahead with some plans such as raising the number of shares, mergers and acquisitions, etc.

5. Companies listed on a stock exchange must a board of directors that are independent and capable of doing their jobs. At least in theory.

As you can see trading on the stock exchange offer some advantages. Even though when trading you have to pay some fees, i sincerely believe that the advantages far outweigh the disadvantages. In fact if you are buying for the long term the gain on the long term will be far greater than the fee.

So guys be safe and trade on an exchange.

Good investing.

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Thursday, April 9, 2009

What is market capitalisation?

There are two terms that define the value of the company.

1. The asset value
2, The market capitalisation

The asset value

The asset value is typically the total commercial value of all the buildings, equipment, furniture, patents , etc of the company. Typically everything that can be sold for a price. The reason that asset price is not used is that investors prefer to use market capitalisation as it is a better estimate of the company's ability to make a profit. A lot of asset is not an indication of the ability to make profit.

The market capitalisation

The market capitalisation can be calculated using a simple formula

Market capitalisation = share price X number of oustanding shares

Companies are classified in six broad categories depending on their market capitalisation.

Mega cap

A mega cap company is one that has a market capitalisation greater that $200 billion dollars. These companies are generally large and profitable such as Exxon. There are few of them. Generally their shares are quite expensive and difficult to obtain. If you have them in your portfolio keep hold of them.

Large cap

A large cap is a large company with a market capitalisation of $ 10 billion to $ 200 billion. Examples are Microsoft and IBM. These companies are relatively safe to invest but just as the mega cap their shares are relatively expensive and difficult to get. If you have them keep them unless a major catastrophe will befell the company.

Mega caps and large caps are also called blue chip companies. They are relatively secure to invest in. If you can get your hands on them in this bear market buy them and keep them. You will hold them for the long term.

Mid cap
A mid cap company has a market capitalisation of between $2 billion to $ 10 billion. However these companies offer greater return to the investor but a few of them will certainly fail. This make them a risky bet for the investor so it is better to limit your exposure to mid cap to not more that 20 %.

Small cap

A small cap company is relatively young and has a market capitalisation of between $ 300 million to $ 2 billion. Such a company offer great opportunity for growth. Imagine that if you invested in microsoft when it was a small cap you would be rich today. However a lot of small cap

Smaller companies are called micro caps and nano caps. They are very risky and if you want to invest in them you have to be very careful and limit your exposure to them to just a few percentage points of your wealth.

One last piece of information is that this information is not valid for every country. It is made for multinational companies. If you want to have your own classification for say Egypt, you will have to take the biggest company by market capitalisation and called it a mega cap and classify the other companies according to their market capitalisation.

Good luck. As usual i would like to give this advise again. As a new investor you should limit your exposure to small caps and mid caps. Only after having gained some experience and being able to analyse companies can you increase your exposure to them.

Happy investing.

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Fees and commissions and how they affect your portfolio.

One of the things that you do not hear often is the impact of fees and commissions on your portfolio. Their is a good reason for this. The financial system has no advantage in whether your portfolio grow and shrink. That is because they derive their incomes from fees and commissions.

When you start investing you need to know that whenever you do a transaction you will need to pay a commission. When you buy or sell a share or any investment instrument you pay a commission. You might not realize it but if you start with a small sum you will soon find that you will have paid a large part of it to the brokerage firm as commissions.

To understand what it meant to your portfolio. Lets assume that you invest 1000 dollars with a fee of 10 dollars per transactions. You buy five types of shares. The fees is now 50 dollars. This is 5% of the investment. So if your portfolio has a rate of return of 5% per year then it meant that you will have to wait more that one year just to break even. So imagine that you start to buy and sell shares very soon your portfolio will start to shrink at a rate of 5 dollars per transaction. As you can see it is not a viable option for the new investment to trade often. That is the reason that I favour the buy and hold strategy, at least in the first few years.

So what to do?

When it come to fees the different instruments are not equal to each other. So here is an analysis of different instruments and how they differ when it come to fees.

1. Bonds, gilts and treasury bills.

These can be available at any central bank or their regional offices. They come with little fees.
However their return is not that mush.

2. Exchange traded funds, mutual funds and index funds.

These are my favorite when it come to reduce fees and commissions. It is ideal for the beginner investor. In fact it reduces the impact of diversification which is a great fee and commission eater. I think that a beginner should stick with these funds until they can understand the market and trade on their own in stocks.

3. Stocks

Stocks is the investment instruments that has the highest fees and commissions. In order to have a good portfolio an investor will have buy into many stocks and that will make the initial commision payable high. So i would advise any new investor to stick to bonds, cds, and funds.

4. CD, Certificate of Deposits

These come with small fees and some banks do not charge any. But Beware most banks do have a penalty when to come to taking your moner before the maturity date.

As you can see the fees and commisssions should be kept in mind if you a new investor. If you are not careful the only person that will benefit is the broker.

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